Saturday, October 3, 2009

OPEC members, Iran and Venezuela, have recently called for changing the currency basis for crude oil from US dollars to Euros. What’s behind this move?

The following graph shows the FOB prices of OPEC crude oil in $/B and Euros/B.

The data reveal that the weakening dollar has translated into a loss in OPEC’s buying power in international markets. The 30% drop in the exchange rate provided an incentive for OPEC to increase prices.

The weak dollar is tied to the increased national debt that has grown from $5.7 trillion at end of the Clinton administration to $9.1 trillion today. Of this debt, $5 trillion is held by the public including $2.25 trillion by foreign governments and $4 trillion is held by the federal government. Total debt is now 77% of GDP (Gross Domestic Product) or $33,000 per U.S. citizen.

The largest foreign holders of U.S. debt are Japan ($582 billion), China ($397 billion), United Kingdom ($266 billion) and oil exporters ($126 billion).

The United States must reduce this debt by decreasing borrowing, saving money and exporting more goods and services. Much of this problem relates to oil imports which made up 27.6% of the 2006 trade deficit.

America’s oil appetite has to take some of the responsibility for the increase in the debt and decline in the value of the dollar. Increasing imports reduce economic activity and increase the cost of U.S. goods. Spending on the Iraqi war to maintain stability in the Middle East and ensure continued flow of oil imports also increase national debt and weaken the dollar.

At some point these forces may send the economy into a tailspin. Unfortunately, like the national debt these future hardships will be borne by the American public who will be victimized again by poor government decisions.